On the trade-offs in the Budget

Raising the level of GST – which will hit those on low incomes the hardest – and offering in compensation a package of tax cuts that will reward those on high incomes the most, is a very strange definition of fairness. Yet fairness and virtue have been central to the spin on Budget 2010. Finance Minister Bill English has been at pains to present his Budget 2010 package as being all good things to all good people – an elixir that will contain a reward for effort, be motivational to all and fair to everyone.

The new income tax rates that will kick in on 1 October, English explained by way of example, will offer an ‘incentive’ for those who mightn’t otherwise decide to work that extra hour of overtime. (On Planet English, everyone is in work and has the luxury of doing overtime, or not.) Lets put to one side the fact that wages for many are so low that people need to work overtime – when they can get it – to make ends meet. The wider reality is that Budget 2010 will cement in place our existing levels of income inequality, or worse. English explicitly recognised this outcome, but portrayed it in benign, or neutral terms. The income tax cuts, he promised, “will more than offset the rise in GST – and low, middle and high income earners will broadly receive the same proportionate increase in disposable income.”

Errr, and this “same proportionate increase” is supposed to be a good thing? Here we have a $4.6 billion package of tax changes – allegedly the biggest change in tax policy we have seen in decades and part funded on the back of borrowing and further interest payments – and the best that we can hope for is that it will repeat the existing pattern of income inequality, with even bigger numbers? I think this will prove far more difficult to sell to the public than it was to the crowd in the Budget lock-up.

Reason being, the increase in GST is politically unpopular, full stop. By next year, the effects will be evident every time members of the public (most of whom are on low or middle incomes) go to the supermarket or the corner grocery. Every time they read the higher price on the docket, they will be reminded of how little net gain they received from this Budget tax package ($6.26 a week, or $326.72 a year for those on the median wage of around $30,000) and how paltry that is compared to the huge net benefits being showered on those earning say, $120,000 – who will get $56.08 net a week, or $2,916 a year. As Clayton Cosgrove argued in a fiery speech to the House last night, the Maori Party is going to find it particularly hard to sell those kind of numbers to its people, as being just and fair. Much as it might point to the cultural gains that it makes by being in government, do these wins really balance out the Budget outcomes, which are squarely to do with how people actually earn a living?

If anything, the gaps between rich and poor will probably be even bigger than officially estimated. Treasury has assumed, when calculating the net impact of the GST rise vs tax cut trade-off, that rich and poor alike spend all of their weekly income. That may be true of the poor as they try to procure the basics of survival – yet it is certainly not true of those on high incomes, who have far more discretion on how, and whether, they spend.. The rich will not incur GST say, when they invest – in ways that do not attract GST – and thus, their discretionary income after the tax cuts will be even larger than Treasury has estimated.

Incidentally, the example I gave before will test English’s claim that under his tax changes everyone will receive broadly “the same proportionate increase in disposable income.” In reality, those who are already on a gross income of $120,000 – four times the median wage – will end up with nearly nine times the net outcome from Budget 2010, compared to someone on or near the median wage. As No Right Turn has calculated, the top 2% of earners will get 11.5% of the total income tax bounty, and that happens to be roughly the same amount as the government has had to borrow to finance the entire package. Literally, New Zealand is borrowing to provide tax cuts for its most wealthy citizens – and again, the Maori Party will have to justify to its constituents that the higher price they’re paying for tobacco and cigarettes is actually funding a corporate tax cut. To repeat: the Budget tax measures will do nothing to address the existing gaps in income inequality, with the usual dire consequences that inequality has for health outcomes, the sense of social exclusion, and crime rates.

As for those on benefits, there will be a 2.02% boost in their incomes in October to compensate for the rise in GST. English has indicated that the position of those on benefits will be re-assessed in April 2011. Presumably, to see if the token compensation for the GST hike has been adequate.

Keeping People in New Zealand

Earlier in the week, Prime Minister John Key had famously warned New Zealanders not be jealous if some of us should receive more from Budget 2010 than others. Such outcomes, he maintained, were necessary if we were to retain the people earning more than $70,000 that we need – such as, he gave by way of example, the nurses, lawyers, accountants and scientists that are crucial to the economy. “Those people are in demand all around the world and we need to have their careers here, put to work in New Zealand,” Key said.

Besides being outrageous in a “let them eat cake” kind of way, the claims didn’t really make sense. Given that OECD researchers have just declared that New Zealand already has one of the lowest tax burdens among OECD countries, why should such prize citizens be driven by our tax rates to emigrate somewhere else, where they would almost certainly be taxed higher – and how can this dodgy reasoning serve as a rationale for lowering our tax rates even further? Especially when the New Zealanders we are losing are not only (or mainly) high earners, as Vernon Small and Martin Kay pointed out on Budget eve in the Dom-Post:

Figures from Statistics NZ show workers from all areas of the economy – many in low-paid jobs – are heading across the Tasman.

Specialised managers made up the biggest group leaving permanently for Australia in the year to September 2009, but housekeepers, restaurant workers, drivers and labourers were among the top 10 occupations of the 23,102 people who left in that period. Nurses, teachers and finance and sales professionals were also in the top 10.

Nurses Organisation adviser Glenda Alexander said registered nurses with five years’ experience earned on average $60,000 a year. The union was surprised nurses had been included in Mr Key’s list of the highest paid.

The drivers of outward migration are the quest for jobs and better wages – not lower tax burdens. We had comparatively low tax burdens before the Budget, and they weren’t doing us much good. More of the same will make little or no difference. As for attracting prize immigrants, our stoic faith in the 1980s notion that tax cutting results in sustainable economic growth will probably deter as many bright people as it attracts. The rest of the world got over its brief fling with voodoo economics a long time ago.

Tax Cuts and Growth

Will the tax cuts deliver economic growth, savings, jobs and higher wages? For decades, right wing economists have claimed– both here and overseas – that tax cuts are a crucial engine of economic growth. Reality, as often as not, has begged to differ. Here in New Zealand during the mid 1980s, a major package of tax cuts was followed by years of little or no growth, and ultimately, by a recession. In the early 1990s, Bill Clinton’s tax hikes immediately preceded the longest and most sustained economic boom in the US since the Second World War. In 1998, the true believers in the National government were predicting that tax cuts would foster savings – fully one third of that round of tax cuts, Treasury predicted, would be saved. They weren’t. In 2000, the incoming government hiked up the top tax rate – and this neither caused, nor prevented, a prolonged bout of economic good times. Ultimately, there is no essential link, either way, between tax cuts and economic growth.

This time at least, business can be held accountable for its rhetoric. English has given our private sector a brief edge by cutting the corporate rate to 28%, a couple of points below the rate in Australia. Let’s now see what, if anything, business can achieve with this handout. Elsewhere in the package, the 38 per cent top income tax rate for those earning over $70,000 has been brought down to 33 cents, in line with the tax rate for trusts – a move that, supposedly, will deter the prior incentive this created to avoid tax.

We shall see. Surely by the same logic, tax lawyers will now be able to drive a truck between the 5% gap that has now been opened up between that 33% top income/trust rate, and the new corporate tax rate. Incidentally, if so many people were ignoring and avoiding the old top tax rate that the government felt it had to change the rules to reflect actual practice, why doesn’t it take the same approach to the laws on cannabis?

Unfortunately, the government has made only a popgun attack on property speculation. This would have to be the single most disappointing feature of the Budget. For all the Tax Working Group huffing and puffing last year about how the tax treatment of property investment was a prime distorting feature of the New Zealand economy – and it is – the government has rejected the main weapons that would be effective against it. Long before Budget day, we already knew there would be no capital gains tax and no land tax, however minimal. In the 2010 Budget though, there is not even a proper ring fencing of depreciation – in sum, only those buildings meant to last 50 years or more will not qualify for depreciation write-offs, and only the extra 20% depreciation loading for new buildings will be scrapped.

Supposedly, punters will no longer be able to juggle their investment losses to get their income down, and qualify for state assistance. To that end, people will no longer be allowed to write off their losses on investments, including those in the rental property market, against their income in order to qualify for Working For Families benefits. Yet tax lawyers again, should have a field day with the definitions and the qualifiers. Crap buildings not meant to last for 50 years? As we’ve shown with the leaky buildings fiasco, we’re very good at building those. Depreciation write-offs for other than WFF purposes? Probably. In February remember, English was still describing the problem in these stark and sober terms:

New Zealanders have $200 billion invested in rental properties – nearly four times the size of the entire New Zealand sharemarket. In 2008, it produced a negative taxable return of $500 million and $150 million in tax revenue losses.

Well, his response to a problem of such magnitude has proved to be limp indeed. As he conceded at the lock-up, the moves on depreciation will really only significantly affect those with multiple property investments. It does seem as if the property investment lobby has rolled the government, almost totally. Certainly, Budget 2010 contains nothing like the game changer that was needed to channel investment into the productive areas of the economy, as was once fondly imagined by the Tax Working Group.

Borrowing for Tax Cuts, and for Rodney Hide’s empire.

As many have noted, the Budget tax package is not fiscally neutral, as English promised. We will be borrowing – to the tune of over $400 million initially – to finance it. According to English, this borrowing was mainly to enable the package to kick in on October 1st, rather than next year. Even so, how can the government justify borrowing to finance a $4.6 billion tax package that will mainly benefit the wealthy few on one hand, while continuing to cite the deficit/debt position as a pressing rationale for reducing the provision of public services to everyone else? Deficits are being forecast until 2015/16.

In this climate, the ideological playground that the Budget intends to build for Rodney Hide really rankles. According to the Budget papers, a new right wing think tank called the New Zealand Productivity Commission will be created at taxpayer expense. Some 29 government agencies have been tapped to donate $2.4 million for this new bureaucracy this year, rising to $5 million by 2012/13. Ayn Rand, it seems, has been nationalized. According to Hide, his Productivity Commission “will provide independent policy advice [yeah right] based on sound research [by the likes of Peter Saunders of the welfare reform advisory panel?] and engagement with the community [Hide having proved himself an expert at this, during the Supercity process.] As well as undertaking and publishing its own research, the new bureaucracy “will promote public understanding of matters relating to productivity.” It will employ three or four Commissioners, and about 20 staff.

The indulgence of Hide is a small but symbolic sticking point – especially given that the Act Party’s response to the Budget has been to call for even greater inroads into state spending. As yet, no one knows the division of labour between this new outfit and the Brash 2025 Task Force, which seems to be doing exactly the same thing. Hide says that his productivity boosting team will be co-operating with the Australian Productivity Commission – and that, surely, must be sitting squarely in Brash’s theatre of operation. Either Brash or Hide (or both) have to be sacrificed. In order, you know, to free up funds that could be better spent on front line services.

Looking Ahead

The political effects of the GST/tax cuts trade-off will not become apparent for some months after its enactment in October. The tax cuts and GST hike will fuel inflation, which is already galloping towards an annual rate of 6% – a prospect that will inevitably induce Reserve Bank governor Alan Bollard to hike interest rates several times between now and the next election, and add to mortgage costs.

The likelihood that the Budget tax package will trigger higher mortgage payments has not, of course, been factored into the Budget response. Nor has the pattern of flow-on costs associated with the Emissions Trading Scheme in July –which will add yet another element to the basket of higher costs that will determine how this package finally plays with the public. In 2008, Michael Cullen was also being praised by the media for a deft piece of Budget maneouvring on the night – but that effort proved to have no legs at all. This time, it could take until early 2011 before the full reality kicks in about how little this package really does to protect the bulk of the public from the barrage of rising prices.

At which point, English will have a few other tricks up his sleeve, in reserve. Given the healthy clip at which inflation is picking up pace, the government will have plenty of motivation next year – six months out from the election – to drop the other shoe on tax reform, and alter the thresholds at which these new levels of tax will cut in. English can easily have two bites, at the same apple – with the gamble being that inflation and growth would take care of the risk of any revenue shortfalls. In the lock-up, English was asked about why threshold changes hadn’t been considered as well, this time. His answer made it clear that changing the thresholds had not been ruled out, sometime in future.

Truth be told, the morphing of English in and out of Cullen mode yesterday was at times a little unnerving. In absence, Cullen’s stewardship even received some praise : “Low government debt before the crisis,” English conceded, “had been one of the offsetting considerations to both international investors and rating agencies when they were assessing the country’s riskiness.” Given the current concerns about sovereign debt – eg Greece – this position, English added, cannot be taken for granted,

Given that with a few tweaks one could imagine Labour enacting a lighter version of this Budget, Labour has found it hard to get much traction so far in combating the Budget tax trade-off. Oddly, it is putting a lot of store on the policy wonk point that rising inflation will erode the value of much of what the Budget contains – which somewhat blurs its attack on the fundamental trade-offs contained in the package. Nor can Labour convincingly criticize the lack of bite in the property investment moves – given how unwilling they were in office to tackle the same problem.

Essentially, this Budget and its related spin is a confidence gambit. With the recession now receding – English even referred in the lock-up to a “booming” economy – and commodity prices still relatively high, the government is hoping that the happy talk about the tax cuts will finally unlock the final weak part of the equation – retail spending in the domestic economy.

Unfortunately, feel good economics can only take people so far, once confidence starts to collide with reality. At that point in the election cycle, the people who will be hurting the most would not be voting for National anyway, and those who vote for the Maori Party will have to be content with other consolations, besides having money in their pockets. At which point and as mentioned, English can always tinker with the income thresholds in Budget 2011, to lock in those crucial middle income votes.

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